Better off on their own? - dades.grupnaciodigital.com

EU Monitor European integration

Publication of the German original:

December 17, 2014

With the independence referendum in Scotland and unofficial polls in Catalonia

and Veneto, separatist aspirations in Europe were recently given a boost. The

desire for greater autonomy in several regions of Europe is not about to ebb in

the coming years either.

In regions seeking greater self-determination or even full secession, not only

emotional and cultural aspects play a role but also concrete financial motives.

Even though autonomy movements are, by definition, regional phenomena,

there are interesting correlations on the economic side.

Nearly all the regions seeking greater autonomy are among the wealthiest in

their respective countries and far outstrip the national average in terms of per

capita income. This comes as no surprise, since secession from an existing

federation goes hand in hand with sizeable risks which economically weak

regions can scarcely afford to take.

Moreover, some of these regions are substantial net contributors in regional

redistribution systems. However, here too there are notable exceptions.

It is striking that there are very persistent regional income disparities within the

countries examined. Most of the regions that have a high per capita income in

relation to the rest of the country have ranked at the top or at least near the top

of the standings for decades. This aspect might have reduced acceptance of the

idea of horizontal redistribution between regions.

Authors

Frank Zipfel

+49 69 910-31890

[email protected]

Stefan Vetter

+49 69 910-21261

[email protected]

Daniel Pietzker

Editor

Barbara Böttcher

Deutsche Bank AG

Deutsche Bank Research

Frankfurt am Main

Germany

E-mail: [email protected]

Fax: +49 69 910-31877

www.dbresearch.com

DB Research Management

Ralf Hoffmann

February 6, 2015

Better off on their own? Economic aspects of regional autonomy and

independence movements in Europe

Basque County

Navarre

Catalonia

South Tyrol

Veneto

Brussels: 185% London: 172%

Scotland

Hamburg: 165%

60%

70%

80%

90%

100%

110%

120%

130%

140%

ES IT BE UK DE

% of national average, 2011; regions with autonomy movements in red; Belgium: Flemish provinces; Scotland: excluding oil revenues

Per capita income: Regions with autonomy movements versus other parts of country DX

Sources: Eurostat, Deutsche Bank Research

Better off on their own?

2 | February 6, 2015 EU Monitor

The new European regionalism

2014 will be remembered as a year of resurfacing regionalism movements in

Europe. Voting on the possibility of independence for their regions – with each

having a differing constitutional character – the people of Scotland, Catalonia

and Veneto have expressed their desire for a greater degree of regional self-

determination. In other regions, too, such as the Basque Country and Flanders,

a substantial part of the population advocates far-reaching autonomy or even

full secession from the current structure of government. What is behind this

desire for more independence, behind the conviction that a region is stronger on

its own than in an entity including the other regions of the country?

Many European regions have preserved a cultural identity of their own. The

sense of belonging that this has created extends, in fact, in some cases across

national borders (take, for example, the Basque Country, which today is split

between Spanish territory and French territory). Cultural differences that have

grown over time are also to be found in Scotland and Catalonia, for instance, yet

these alone are not sufficient to explain the emergence, or resurgence, of

independence movements. Finally, there are also regions which today, despite

centuries of sovereignty or unity with another nation, no longer show any

interest in changing the status quo. Nationalists occasionally assert that they

face discrimination in a centralised state, but their reasoning often seems very

hard to follow. At any rate, these regions are a part of pluralistic democracies,

and the right to enjoy fundamental freedoms is guaranteed, moreover, by the

EU and the European Court of Human Rights. The emotional dimension of this

aspiration for independence often has a very specifically regional background

and therefore does not play a central role in this report.

However, the economic dimension is likely to play a role of presumably equal

importance. While there are few reasons, from an objective point of view, why

Scotland or Catalonia should gain a substantial degree of prosperity via

independence, nationalist parties cite this very issue as being one of the most

important arguments. Secession from an existing state structure harbours huge

economic risks, though. However, these risks have decreased for smaller

countries; paradoxically, this is especially due to European integration. After all,

access to the single European market and the option of eurozone membership

reduce some of the fundamental disadvantages that would otherwise be faced

by countries such as Luxembourg, Malta, Cyprus and the Baltic states. Even

though a seceding region would probably have to officially apply for EU

membership, this very prospect no doubt makes it much easier for supporters of

independence to paint a positive picture of a future as a sovereign nation.

This report will focus on examining the extent to which economic determinants

could provide an explanation of why autonomy movements are emerging or

becoming reinforced. On the one hand this includes the question of whether the

citizens of a given region might have the impression that it is so strong

economically compared to the rest of the country that it could form a functioning

and internationally competitive state even if it were independent. On the other

hand, a role is also played by whether extensive interregional transfer systems

compel wealthier regions to share their prosperity with poorer regions. If the

subsidisation of other parts of the country reaches a high level or there is not a

very pronounced sense of solidarity with other regions, this can also serve as a

motivation for greater autonomy.

Contents

The new European regionalism 2

Overview: Regionalism and economic

vitality .......................................................... 4

Spain: Unequal rules aggravate problems .. 6

Scotland: Increasing autonomy ................. 11

Belgium: Increasing division ...................... 14

Italy: Large gulf between north and south . 16

Germany and France: Autonomy movements

have no major political significance ........... 18

The financial illusion of independence 19



Autonomy or independence? Regions have varying starting conditions, motives and objectives

Autonomy movements are, by definition, regional phenomena and thus

comparable to an only limited extent, especially since the regions discussed

here enjoy differing degrees of autonomy. While the demand for greater self-

determination is borne everywhere by a broad swath of the population, the basis

for seeking actual independence varies in breadth.

In Scotland some 44.7% of the vote in the September 18, 2014 referendum was

in favour of independence, on a turnout of nearly 85%. While the unofficial poll

in Catalonia on November 9, 2014 showed an overwhelming majority of 80.76%

in favour of the pro-independence camp, the turnout came to merely 37%,

corresponding to "only" about 30% of Catalonia's eligible voters. An unofficial

referendum without a legally binding effect is a difficult benchmark for

comparison anyway. Catalonian voters could vote for independence also to

express general dissatisfaction without triggering any immediate consequences.

The opponents of separation largely boycotted the referendum, and the

absence of legal binding is likely to have kept many other voters from casting

their ballot. This provides only limited grounds for predicting what the outcome

of a constitutionally binding referendum would be like.

Another Spanish region with a strong autonomy movement is the Basque

Country. Unlike Catalonia it has much more extensive autonomy rights, not least

in terms of financial matters. The Basque Country is the only one of the regions

analysed here whose desire for independence has manifested itself in the

formation of a terrorist movement (ETA). In the neighbouring region of Navarre a

part of the population feels it belongs historically to the Basque Country. There,

it is not only a matter of nationalism in its own right, but also a sense of having a

common Basque identity. The political spectrum includes not only Basque

parties but also parties claiming autonomy for the region itself. Like the Basque

Country – but unlike Catalonia – Navarre also enjoys special autonomy status

within Spain.

The relationship between Flanders and the rest of Belgium is a special case. For

one thing, this is the biggest region of the country in which a substantial share of

the electorate desires secession while, for another, Belgium does not even have

a common national language that creates a sense of identity. This linguistic

segmentation differentiates it from Spain, where several regional languages are

recognised (e.g. Basque, Catalan, Galician) but in principle everybody grows up

with Castilian Spanish as their (at least additional) mother tongue.

The language component also plays a part in Italy's South Tyrol (Alto Adige),

where German is still the most widely spoken language. Our references to

South Tyrol in the following pertain to the "Provincia autonoma di Bolzano-Alto

Adige", which together with the "Provincia autonoma di Trento" forms the region

of Trentino Alto Adige. Over the past few years the region of Veneto has also

seen the development of a movement calling for a right to self-determination

and a binding referendum on its affiliation with Italy. In an unofficial online

referendum organised by private groups in March 2014, unconfirmed reports

from the organisers say that 89% (or 57% of the total electorate) voted in favour

of independence.

44.7%

37.8%

55.3% 46.7%

0%

10%

20%

30%

40%

50%

60%

Percentage of votes cast

Percentage of electorate

Yes No

Referendum on Sep 18, 2014: “Should Scotland be an independent country?” 1

Turnout: 84.6%

Source: Electoral Management Board for Scotland

80.8%

29.9% 10.1% 3.7% 4.5% 1.7%

0%

20%

40%

60%

80%

Percentage of votes cast

Percentage of electorate

Yes, independent Yes, within Spain No

Referendum on Nov 9, 2014: “Do you want Catalonia to become a State?” 2

Source: Generalitat de Catalunya

Estimated turnout 37% (no official figures)



Overview: Regionalism and economic vitality

The regions seeking greater independence differ very considerably in terms of

geographical size and economic importance. Both very small as well as very

much bigger regions desire greater autonomy. Their weight within the given

country is correspondingly uneven. Flanders (58% of Belgium's GDP) and

Catalonia (19%) are regions, for instance, that are of huge economic relevance,

while South Tyrol (2.3%) and Navarre (1.7%) play a relatively minor role in their

respective countries.1

The most striking common characteristic of these regions is the usually high

level of prosperity compared to the rest of the country. Nearly all the regions

rank higher than the national average in terms of per capita income (see chart 3

and table 4).2 This is particularly noticeable in Spain and Italy, where the

Basque Country and South Tyrol, the most prosperous regions in their

respective countries (with GDP at over 130% of the average), already enjoy

special autonomy status. Belgium presents a comparable picture – if one

disregards the capital region of Brussels nearly all the Flemish provinces

outstrip the national mean. Per capita GDP is 37% higher in Flanders than in the

provinces of Wallonia.

The situation is similar in Scotland: while the income level is somewhat lower

than the British average, Scotland follows London and the neighbouring south

east as the third-richest of twelve regions. One further special feature also has

to be taken into account: the North Sea oilfields are currently not assigned to

any region of the UK in the official statistics. When the GDP generated by oil

deposits is allocated on the basis of geographic share, Scotland's per capita

income rises from EUR 26,200 to roughly EUR 32,000 and would thus equal

some 115% of the British average3. On the basis of records available since

2000, Scotland would thus be the second richest region of the UK by far after

London.

1 The following abbreviations are also used for the regions: Basque Country (BC), Catalonia (CT),

Navarre (NA), South Tyrol (ST), Veneto (VE), Flanders (FL) and Scotland (SC). 2 For Germany (DE) and the United Kingdom (UK) we look at the NUTS 1 level, and for the other

countries NUTS 2. 3 Shares are allocated according to a geographical division based on what is known as the "median

line". In this procedure, every point on the maritime boundary is equidistant from the shores of the

two countries. This system is also used to divide the coastal fishing areas in the UK, for instance.

This means that around 85-90% of the oil deposits are on Scottish territory (for more on this topic

see Kemp & Stephen, 2008). The method is used by the Scottish government, with the value

representing an upper limit.

Independence movements in Europe: An overview 4

Comparison of various regional indicators in relation to the rest of the country

Country Region Pop. (abs.) Pop. (%) GDP (abs.) GDP (%) GDP/

capita

GDP/

capita (%)

Unempl.

(pp)*

Basque Country 2.18 m 4.7% 64.9 bn 6.2% 30,500 134.4% -9.5

Navarre 0.68 m 1.4% 18.1 bn 1.7% 29,100 128.2% -8.2

Catalonia 7.49 m 16.1% 194.3 bn 18.6% 26,600 117.2% -3

South Tyrol 1.02 m 1.7% 35.8 bn 2.3% 34,385 132.3% -6.7

Veneto 4.85 m 8.2% 149.5 bn 9.5% 30,200 116.2% -4.6

BE Flanders 6.36 m 57.5% 212.4 bn 57.5% 33,600 100.0% -3.4

UK Scotland** 5.28 m 8.4% 137.9 bn 7.8% 26,200 92.9% -0.4

Source: Eurostat

** Excluding oil revenues

* Difference in unemployment rate to national average

ES

IT

BL

NA

KA

ST

VE

Brussels

London

SC

HH

60%

80%

100%

120%

140%

160%

180%

ES IT BE UK DE

Per capita income versus other regions in given country 3

% of national average, 2011

Regions marked in red; Belgium: Flemish provinces; Scotland: excluding oil Sources: Eurostat, Deutsche Bank Research

80%

90%

100%

110%

120%

130%

140%

1995 1999 2003 2007 2011

Basque Country Navarre

Catalonia Flanders

South Tyrol Veneto

Scotland* Scotland**

Growth of per capita income in relation to national average 5

% of national average

*Excl. oil revenues, **Incl. oil revenues

Source: OECD



The regional income disparities within a country are very persistent (see chart 5

as well). Since 1995 the ratios have shifted only slightly in many cases. The

Basque Country has gained most in relation to the national average and

boosted its per capita income from 118.9% to 133.7%. In the other regions the

ratio has remained relatively constant: Navarre and Flanders are up slightly

(with +2.6 percentage points and +1.9 pp, respectively), while South Tyrol (-2.7

pp), Scotland (-3.6 pp), Veneto (-4.4 pp) and Catalonia (-4.5 pp) have lost

ground.

Due to their higher prosperity levels these regions score much higher on many

economic and social indicators than the rest of their country. Whether

unemployment, poverty, education or research: in some cases there are

sizeable differences to the national average in these areas. For example, all the

regions score better on unemployment and poverty rates. Since the start of the

crisis the unemployment rate has not risen as much, as a rule, as in the other

regions. In the Basque Country the rate rose by 4.8 pp less than in Spain as a

whole from 2008 to 2013. Navarre (-3.7%), South Tyrol (-2.9%) and Veneto

(-1.4%) are also positive outliers in their countries. Catalonia (-0.6%) and

Flanders (-0.3%), as well as Scotland (+0.5%), performed in line with the

average (see chart 6).

Income inequality within these regions is much less pronounced than in the rest

of the respective country (see chart 7), which does not automatically have to be

the case despite usually higher per capita incomes. The Gini coefficient4 is

smaller in all the regions than in the country as a whole – both before as well as

after redistribution via taxes and transfers. The largest disparity is to be found in

Navarre, where the Gini coefficient is 0.07 lower (before taxes and transfers)

and 0.05 lower (after taxes and transfers) than the coefficient for Spain as a

whole. A similar picture emerges with regard to the income ratio between the

80% quantile and the 20% quantile. Only in Scotland is the gap between the fifth

of the population with the highest incomes and the fifth with the lowest incomes

minimally larger than the national average, while in the other regions the

difference between the population groups is smaller.

The regions analysed score above average not only within their countries but

also in a European comparison of per capita incomes (EU-27). South Tyrol was

the leader of the group in 2011 with GDP per capita of 137% of the EU mean,

followed by Flanders at 134%. At the lower end of the scale are Catalonia

(106%) and Scotland (excluding oil, 105%), which – just like the rest of the UK –

had suffered a severe slump due to the financial crisis. In 2006, Scotland still

boasted a reading of 132%.

The regions are not only affluent in relative terms though. Their absolute

economic output also makes them a force to be reckoned with even at the

European level (chart 8). A recurring theme used as an argument against the

separatist movements is that the resultant countries would be relatively

meaningless at the national level because of their small size, apart from other

problems. A glance at the EU shows, however, that many of the regions would

not be such lightweights at all in comparison with existing members. In fact, in

terms of GDP, Flanders and Catalonia even have bigger economies than

Portugal or Ireland. The medium-sized regions of Veneto and Scotland

outperform countries such as Romania and Hungary, and even the Basque

Country has a larger GDP than nine other EU members. In terms of population,

too – a factor of significance for voting procedures in EU bodies in particular – a

host of regions indeed boast critical mass.

4 The Gini coefficient is a measure of income inequality and has a value between 0 and 1. A

reading of 0 means that all incomes in the respective region are distributed evenly. If a region has

a lower Gini coefficient than the rest of the country the inequality of income distribution there is

not as pronounced.

-5 -4 -3 -2 -1 0 1

Basque C

ountry

Navarre

Cata

lonia

South

Tyro

l

Veneto

Fla

nders

Scotla

nd

ES IT BE UK

Unemployment rate: Region vs rest of country; 2008-2013 6

Difference to increase in national average (pp)


-0.08

-0.06

-0.04

-0.02

0

Basque

Country

Navarre

Cata

lonia

South

Tyro

l

Veneto

Fla

nders

Scotla

nd

ES IT BE UK

Before taxes/transf. After taxes/transfers

Gini coefficient before and after taxes and transfers

Income inequality: Difference to national average in 2011 7

Source: OECD

0 50 100 150 200 250 300 350

Norway

Austria

Flanders

Catalonia

Portugal

Ireland

Belgium*

Veneto

Scotland**

Romania

Hungary

Basque Country

Luxembourg

Slovenia

South Tyrol

Latvia

Navarre

Estonia

Malta

Comparison of selected countries and regions 8

GDP, EUR bn, 2011

*Belgium excl. Flanders, ** Excl. oil

Source: Eurostat



Differences regarding scope of regional autonomy

A very mixed picture emerges as regards the extent of regional autonomy in the

countries analysed. While both Spain and Belgium have already devolved many

competences to the regional level, this is much less the case in Italy and the

United Kingdom. This can also be seen in the data on record: the share of

government spending authorised at the regional level is much higher in Spain

(40.5%) and Belgium (36.4%) than in Italy (29.5%) and the UK (26.1%). This

trend became manifest in the past: in Spain, the shift had resulted in 7 pp of

higher outlays at regional level since 1995, hitting 49.9% before the 2007 crisis

in fact. In Belgium the rate rose by 14 pp from 1985 to 1990, jumping in the

wake of the State Reform of 1988/89 in particular. However, little has changed

in Italy or the UK since the turn of the millennium. This also holds for Germany,

where the share of the regional level in total government spending has hovered

at close to 40% for a long time.

The situation is similarly mixed in respect of tax revenue distribution, too. In

Spain, some 33% of total tax revenues are generated at the regional level; in

this respect, the special status of the Basque Country and Navarre no doubt has

a noticeable impact. In the other countries the share is much smaller: Italy

comes second at 16%, Belgium follows at 10% and the UK at 5%. The share in

Belgium is expected to rise owing to the State Reform in 2014 (by comparison:

the reading in Germany is over 29%).

With regard to public expenditure on investment, it is striking that a particularly

large share is commissioned at regional level. The shares in Belgium (90.2%),

Italy (72.5%) and Spain (69.4%) considerably outstrip the average for the

European members of the OECD (59.5%). Only in the UK is there a slightly

lower share at 54.6%. Local and regional governments thus appear to be

particularly responsible for public investment in the countries analysed (by

comparison: the reading is about 76% in Germany).

To sum up: the regions discussed generally report above-average economic

output, but the importance of the regional level is not equally pronounced

everywhere. There are also major differences in respect of regional funding and

fiscal equalisation systems. So each case has to be assessed on its own merits.

Spain: Unequal rules aggravate problems

Many regions in Spain have a distinct cultural identity, but only in a few of them

did this feeling of regional unity develop into broad support for movements

claiming greater autonomy or independence. This is also reflected in the

importance of regional parties in the political system. The Basque Country,

Navarre and Catalonia have strong regional parties, but Asturias, Galicia and

the Canary Islands also have such parties that were able to attract more than

10% of the votes in the 2011 Spanish parliamentary elections in their specific

region. The share of these parties is usually even higher in regional elections.

However, in the latter regions not many voters support the demand to become

fully independent. A major factor to explain this is presumably that their GDP per

capita is below the national average, and it is hard to find convincing reasons

why they should be better off alone. In contrast, the Basque Country, Navarre

and Catalonia are among the economically strongest regions in Spain – only the

capital Madrid can compete in terms of per capita income and unemployment. In

2013 the per capita GDP of the Basque Country was almost twice that of the

poorest region, Extremadura, while its unemployment rate was only half as high

(see chart 12).

0%

10%

20%

30%

40%

50%

88 92 96 00 04 08 12

Belgium Italy

Spain United Kingdom

Public expenditure at the regional level 9

% of total public expenditure, 1988-2012

Source: OECD

0

20

40

60

80

100

BE DE IT ES GB

%, 2011

Public expenditure on investment at regional level 10

Average for OECD Europe in red

Source: OECD

0%

10%

20%

30%

40%

50%

60%

Sources: Junta Electoral Central, Deutsche Bank Research

% of votes in their home region; only regions with at least 10% are included

Share of regionalist parties in the 2011 general elections 11



While there are some similarities between the Basque Country and Catalonia in

their desire to gain greater (or full) autonomy, it is crucial for an understanding of

the Catalonian dilemma that the two regions are treated differently within

Spain's fiscal architecture. Like most other regions Catalonia has the status of

an Autonomous Community (Comunidad Autónoma), while the Basque Country

and Navarre have had the status of a so-called “Comunidad Foral” since 1979

and 1982, respectively. This special status not only grants a much higher

degree of fiscal autonomy, but also accords preferential treatment within the

horizontal equalisation scheme between regions.

The objective of the equalisation mechanism is to establish a comparable level

of public services across Spanish territory. As a result of marked income

differences but also due to geographical factors, this is much more difficult for

some regions than for others. Consider the two neighbouring regions of Madrid

and Castile La Mancha. Income per capita in Castile La Mancha is almost EUR

10,000 lower than in Madrid. At the same time, the population of Madrid is three

times larger (6.5 m vs 2.1 m) but the inhabitants of Castile La Mancha are

spread across an area ten times larger (roughly twice the size of the

Netherlands). Obviously, it is much more difficult and more expensive for such a

large and thinly populated region to maintain a comparable network of public

infrastructure, healthcare and educational institutions than for regions such as

Madrid, Catalonia or the Basque Country. However, the problematic design of

the regional equalisation scheme is a permanent cause of dispute.

The intricate mechanics of Spain's fiscal equalisation scheme

The fiscal competences and financing schemes of the Spanish regions have

been reformed several times, most recently in 2009. The fiscal equalisation

scheme, the so-called “common system” (Régimen Comun), redistributes

financial resources across regions. However, as the Basque Country and

Navarre have special autonomy status as a “Comunidad Foral” this scheme

does not apply to them. Funding for the fiscal equalisation scheme mainly

comes from shared taxes, for example from 50% of the income tax and 50% of

the VAT. Both components are strongly linked to GDP, which means that richer

regions pay more. In addition, the common system receives 58% of taxes on

alcoholic products, tobacco and fuels, and 100% of taxes on capital transfers,

inheritances and donations, or gambling, as well as some special low-volume

taxes.

The main instruments for redistribution are the Public Guarantee Fund (Fondo

de Garantía de Servicios Públicos Fundamentales) and the Global Sufficiency

Fund (Fondo de Suficiencia Global), whose purpose is to ensure that all regions

in the common system have the same per capita financing for public resources.

Two additional funds (Fondo de Competitividad, Fondo de Cooperación) provide

additional resources for structurally weak regions according to different criteria

(e.g. for those with GDP per capita of less than 90% of the average). With a

volume of EUR 69 bn (6.8% of Spanish GDP) in 2012, the Public Guarantee

Fund was by far the largest fund. The disbursement is based on a region’s

“adjusted population”, i.e. the actual population adjusted for certain factors

which justify additional financial resources to mitigate structural disadvantages

(box 14).5

Some complications arise when comparing net financial flows across regions.

One reason is that some regions can decide whether to assume certain

competences or leave the responsibility to the central state. For example,

Catalonia is the only region in the common system in charge of a police and

5 This compares with what is referred to as "Einwohnerveredelung", the population weighting

approach used in Germany for the Länder financial equalisation system.

Galicia Asturias

Spain

CA

NA

Madrid

BC 15

20

25

30

35

40

15,000 20,000 25,000 30,000

Catalonia, Basque Country and Navarre among the strongest regions 12

X-Axis: regional per capita GDP, 2013, EUR Y-Axis: unemployment rate, 2013, %

Source: Instituto Nacional de Estadistica

100%

110%

120%

130%

140%

1995 1998 2001 2004 2007 2010 2013

Basque Country Navarre

Catalonia Madrid

Regions with autonomy movements more affluent than the rest of Spain 13

100% = national average

Source: INE



penitentiary system, for which it receives financial compensation from the

central state. Another reason is that there are some differences in regional and

local taxes. Furthermore, due to their isolated location the Canary Islands have

a reduced local sales tax instead of the regular VAT, and also the two north

African enclaves Ceuta and Melilla benefit from some exceptions.

Chart 15 illustrates the result of this opaque combination of redistributive

elements.6 The regions in the common system, i.e. excluding Navarre and the

Basque Country, are ranked according to their gross fiscal capacity, which is the

per capita amount of taxes collected in that region. It also plots the per capita

resources after fiscal equalisation between regions. Both measures are

normalised such that a value of 100 corresponds to the national average. It is

evident that the fiscal equalisation scheme indeed achieves the objective of

reducing the disparities across regions (the standard deviation of per capita GDP

is 25%, but that of per capita financial resources after adjustment is only 12%).

A remarkable aspect is that the three richest regions in the common system –

Madrid, the Balearic Islands and Catalonia – are not on top any more after

horizontal redistribution. The change in the ranking is partly the consequence of

accounting for different financing needs, but it is an undesirable feature from the

perspective of incentive compatibility. The seemingly arbitrary distribution gives

rise to claims of richer areas that their contribution is disproportionately large.

Preserving the ranking is a key Catalan demand for fiscal reform. The reformed

regional statute of Catalonia (approved by the Catalan parliament in 2006 but

partly rejected by the Constitutional Court in 2010) stipulates: “The State shall

guarantee that application of the levelling mechanisms shall in no case alter the

position of Catalonia in the pre-levelling ranking of per capita earnings.”7

Regional asymmetries: Navarre and the Basque Country

Thanks to their special autonomy statute, the Basque Country and Navarre

have the power to collect most taxes themselves. They do not participate in the

fiscal equalisation scheme but instead transfer a certain share of their tax

revenues to the central state in order to contribute to the financing of functions

which are located at the national level. Both regions also have more discretion

in setting tax rates than the regions operating in the common system, which

further complicates a comparison across regions. Comparable data are only

6 For details on the calculations see FEDEA (2014). La financiación de las comunidades

autónomas de régimen común en 2012. 7 See Article 206(5). Ley Orgánica 6/2006, Reforma del Estatuto de Autonomía de Cataluña.

(Organic Law 6/2006 on the Reform of the Statute of Autonomy of Catalonia).

Calculation of the "adjusted population" 14

The “adjusted population” concept is based on

the logic that regions with a higher share of

children and pensioners or a low population

density have higher spending needs to

guarantee a comparable level of public

services.

The following weights and variables are used

for the calculation of the “adjusted population”:

VARIABLES WEIGHTING

Population 30.0%

Population younger than 16 20.5%

Population older than 65 8.5%

Economically dependent 38.0%

Population in seven age groups

Surface area of region 1.8%

Dispersion of population 0.6%

Insularity 0.6%

In order to illustrate the effects of the

calculation let us consider the example of

Catalonia.

In 2012, the share of Catalonia in the total

population of the regions in the common

system was 17.10%. The share of the

population below age 16 was only slightly

higher (17.71%), while the share of those older

than 65 was marginally lower (16.82%).

However, the surface area of Catalonia

corresponds to only 6.52% of the total, which

enters with a weight of 1.8%. The result is an

adjusted (i.e. weighted) population of 7.51 m.

Thus, Catalonia receives financial resources

as if it would have to provide public services for

a population of 7.51 m – or 99% of the actual

7.57 m inhabitants. Thus, the adjusted

population concept results in a marginal

disadvantage for Catalonia. For the other

regions, the adjustment factor usually ranges

between 0.95 and 1.05.

Source: Ministerio de Hacienda y Administraciones

Públicas

0%

30%

60%

90%

120%

150%

gross fiscal capacity per capita per capita financial resources after equalisation

Winners and losers of the regional fiscal equalisation scheme 15

100 = national average

Source: FEDEA (2014)



available for the regions within the common system, but a study on behalf of the

Spanish Finance Ministry has recently made an attempt to quantify the financial

flows when the two above regions are included.8 These calculations reveal that

Catalonia and Madrid, the wealthiest regions in the common system, are net

contributors to the equalisation scheme but not Navarre and the Basque Country.

According to these calculations, Catalonia made a net contribution of -4.35% of

its GDP, ranking third behind Madrid (-8.87%) and the Balearic Islands (-5.71%)

in 2012 (see chart 16).9 Compared to a situation of fiscal neutrality, i.e. without

any form of horizontal redistribution, these findings imply an additional cost for

Catalonia of EUR 8.5 bn. By contrast, Navarre and the Basque Country had a

surplus of 0.19% and 2.43% of GDP, respectively. Figure 17 expresses the

same in per capita terms. Regions are ranked according to per capita GDP in

ascending order. The diamonds indicate the per capita financial resources of a

region after redistribution; a value of 100 again corresponds to the national

average. Once again it becomes clear that Madrid and Catalonia are at a

disadvantage compared to the two regions outside the common system.10

Reforming a conflict-ridden system without creating or reviving other conflicts: A mission impossible?

A system of interregional redistribution will always have to strike a balance

between providing support for structurally weaker regions and preserving the

legitimate interests of the net contributors. However, the patently unequal

treatment of regions appears detrimental to the general acceptance of the

system. Concerning the regions with important autonomy movements, a few

central facts clearly stand out:

— Catalonia is a long-running net contributor to a system which achieves

substantial redistribution. This is hardly surprising given that the raison

d’être of a system based on solidarity is that the richer regions support the

poorer ones. Of course, a different – political – question is what degree of

fiscal solidarity is acceptable to the majority of Catalans. In light of the

complexity of the system, the barely comprehensible directions of flows and

the asymmetry between regions with different fiscal regimes, the discontent

of many Catalans becomes more understandable.

8 See de la Fuente, Barberán and Uriel (2014); information only available in Spanish.

http://www.minhap.gob.es/en-GB/Paginas/20140723_scpt.aspx 9 Other sources reach considerably differing conclusions in some cases. Pro-independence groups

usually claim that Catalonia has a much larger fiscal burden in the order of -6% to -8% of its GDP. 10

In addition, the tax burden is slightly lower in Navarre and the Basque Country.

ES

Balears

CA

NA

Madrid

BC

-10%

-5%

0%

5%

10%

15%

20%

15,000 20,000 25,000 30,000

Regions with fiscal autonomy have lower contribution levels 16

X-Axis: GDP per capita, EUR, 2012 Y-Axis: fiscal balance after equalisation,% GDP

Sources: de la Fuente et al. (2014), INE

60

80

100

120

140

160

180

200

GDP per capita Per capita financial resources after equalisation

Asymmetry between regions with/without fiscal autonomy 17

100 = national average

Sources: de la Fuente et al. (2014), Instituto Nacional de Estadistica, Deutsche Bank Research



— Even though the issue is central in the political debate, there does not

appear to be a specific anti-Catalan bias. At least concerning fiscal

redistribution, the often heard claim among Catalan nationalists that the

Spanish state systematically exploits Catalonia’s economic strength hardly

appears justified. After all, Madrid and the Balearic Islands contribute more

both in per capita terms and in terms of GDP.

— Special autonomy status generates significant financial advantages for the

Basque Country and Navarre. As both regions would be net contributors if

they were treated like the rest, this arrangement is clearly unfavourable for

all the other prosperous regions.

Despite the problematic aspects of the current regional equalisation scheme,

any attempt to achieve a substantial reform is bound to encounter strong

resistance. In principle, three approaches appear conceivable, but all of them

are problematic as well:

i. Other regions have repeatedly demanded a reduction of the advantages for

Navarre and the Basque Country stemming from their not being part of the

common system. However, both regions would fiercely resist any attempt to

alter the status quo to their disadvantage.

ii. A “small” solution, which would keep the ranking of the regions and only aim

at reducing the payments of the net contributors, would obviously be

opposed by the net recipients. However, as Catalonia is not the largest net

contributor in per capita terms, the scope for readjusting the system in

Catalonia’s favour is limited and the net effect would hardly be sufficient to

appease the pro-independence camp.

iii. Finally, Catalonia could be granted special status similar to that enjoyed by

the Basque Country and Navarre. While this would presumably be the

preferred solution of many Catalans it would inevitably trigger similar

demands from other wealthy regions (Madrid, La Rioja, the Balearic

Islands). However, such a solution would not only effectively eliminate the

regional equalisation mechanism but also undermine the Spanish national

state.

How the issue of regional finances and fiscal autonomy can be resolved in a

way that is satisfying for all groups involved will remain one of the key questions

for the territorial unity of Spain.

11

For more details on the establishment of the FLA see Vetter, Zipfel and Fritsche (2014). Small is

beautiful? Capital market funding for sub-sovereign authorities on the rise. Deutsche Bank

Research.

The indebtedness of Spanish regions during the crisis and the role of the Fondo de Liquidez Autonómico (FLA) 19

Since the peak of the financial and sovereign debt crisis, an additional – but often overlooked – dimension has been added to the fiscal links between

the highly indebted regions and the Spanish central state.

During 2010 and 2011 the risk premia of regional government bonds were rising even more steeply than for Spanish government bonds. Highly

indebted regions such as Catalonia almost completely lost access to capital market funding and needed to ask for emergency liquidity from the

Spanish government. In early 2012, Catalonia and eight other regions applied for government funding from the newly created Fondo de Liquidez

Autonomico (FLA). This new instrument centralised the raising of new capital for the regions and reduced their refinancing costs. Participation in the

FLA provides regions with long-term loans (10 years plus a 2-year grace period) at almost the same rate as the central government (10 basis points

above Treasury bonds). At the peak of the sovereign debt crisis, this was equivalent to an advantage of well over 100 basis points for all the

participating regions. In return, they had to accept strict fiscal conditionality and financial monitoring by the central government, which was a politically

contentious issue especially in Catalonia.11

The Spanish government has also imposed a ceiling on the costs of bond issuance by the regions. If an

Autonomous Community has to pay a premium which exceeds a certain threshold over Spanish government bonds of identical maturity, it can only

obtain financing via the FLA.

Catalonia is currently the largest borrower from the FLA (around 40% of the total volume) and received EUR 23.8 bn in various instalments during

2012, 2013 and 2014. Creating the FLA was not a cheap solution for the central government, though, since it resulted in risk being transferred from the

regions to the central authority and hence to higher risk premia for Spanish sovereign bonds. The fact that the central government increased its own

borrowing in order to lower the financing costs of Catalonia represents a direct fiscal transfer from the central government to Catalonia (and other

regions) due to the preferential borrowing rate of the FLA. In contrast, Navarre and the Basque Country did not need to apply for funding via the FLA.

Compared to Catalonia their debt level is much lower and they have a much better credit rating, not least due to the higher degree of fiscal autonomy.

0 5 10 15 20 25 30 35

Canary Islands

Madrid

Basque Country

Asturias

La Rioja

Castillia y León

Extremadura

Galicia

Cantabria

Aragón

Andalucia

Navarre

Murcia

Balearic Islands

Catalonia

Cast. La Mancha

Valencia

Regional debt in % of GDP 18

Q2 2014; FLA-regions in light blue

Sources: Banco de Espana, Deutsche Bank Research



Scotland: Increasing autonomy

Despite the existence of three levels of government, i.e. local authorities,

counties and the regions of England, Scotland, Wales and Northern Ireland, the

United Kingdom has historically always been a very centralised country. In

recent times, however, especially Scotland (and to a lesser degree Wales and

Northern Ireland) has gained considerable autonomy. Yet, surprisingly, this

does not apply to England, the largest region of the UK by far.12

The desire for

more autonomy and self-administration had already manifested itself very early

on in the founding of regional parties – in Wales, for instance, back in 1925 and

in Scotland in 1934. Until the end of the 1990s, though, non-regional parties

invariably dominated the elections in the different regions.

The strongest autonomy and/or independence movements are in Scotland – as

evidenced by the latest referendum. Driving this trend are not only emotional but

above all economic/financial factors, the latter in particular being the discovery

of North Sea oil in the late 1960s and its intensive exploitation after the 1973 oil

crisis. An initial referendum in 1979 on greater autonomy and establishment of a

local parliament produced no change. A Scottish parliament was not created

until 1999, only after a further referendum. Since then, its significance has

grown steadily. It has powers especially in the areas of education, agriculture,

health and justice. In Scotland's wake, Wales and Northern Ireland have also

been granted greater autonomy and self-administration. Comparable aspirations

to gain independence have scarcely been visible there to date. The relatively

poor economic performance is likely to have played a major role in this respect.

Scotland already largely autonomous with regard to expenditures

A look at the fiscal level finds that Scotland still only has very limited autonomy

on the revenue side. However, this is set to change in future (see below). On

the expenditure side, though, Scotland already enjoys far-reaching autonomy.

This enables differing emphasis on issues in various areas of its remit. For

example, in a host of areas – on the largest items of health and education in

particular – the Scottish government spends a per capita amount similar to the

national average.13

However, in some fields – such as business promotion,

agriculture and transport – it spends much more per capita than the national

average. Accordingly, though, it expends much less on science and technology,

for instance.14

All in all, it must be noted that in the area of public services Scotland reports

substantially higher spending than the rest of the United Kingdom. At last

reading (fiscal 2012/2013) total spending in Scotland came to around GBP 65

bn15

or roughly 9% of national expenditure of GBP 701.7 bn. This means that

total per capita spending in Scotland is also about 11% higher than at the

national level. The relatively higher expenditures in Scotland are not a short-

12

See Gwilym, Eurfyl ap (2014). United Kingdom, in: Lütgenau, Stefan (2014). Fiscal Federalism

and Fiscal Decentralization in Europe, pp. 61-73. 13

See Phillips, David and Tetlow, Gemma (2014). Taxation, government spending and the public

finances of Scotland: updating the medium-term outlook, IFS Briefing Note 148. June 2014, p. 10. 14

The reasons there are exceptions to the regional governments being able to decide freely on the

allocations available emerge partly from the fact that funds for investment cannot be converted

into current expenditure. However, conversion in the opposite direction is possible. See Gwilym,

Eurfyl ap (2014), p. 64. 15

Even though the Scottish government is responsible for a large portion of the expenditures there

are certain areas – such as defence and foreign relations – where related expenditure is the

responsibility of the central government (and is funded via the national budget). The Scottish

government therefore also factors in the expenditures at national level that benefit the inhabitants

of Scotland. All the data cited here are based on figures calculated by the Scottish government

under this definition. Expenditures calculated on this basis are published under the heading of

total managed expenditure (TME).

60%

70%

80%

90%

100%

110%

120%

1995 1998 2001 2004 2007 2010

Wales Northern Ireland

England Scotland

England** Scotland***

Regional income per capita in the UK 20

% of national average*

*Offshore income stripped out **Excl. London ***Incl. oil revenues Sources: Deutsche Bank Research, data from Eurostat, OECD

Science and technology

Public order and safety

International services

Defence

Employment policies

Education and training

Health

Environment protection

Personal social serv. and soc. protection

Public and common services

Recreation, culture and religion

Transport

Housing and community amenities

Agriculture, forestry and fisheries

Enterprise and economic development

Per capita expenditure in Scotland 21

Expenditures in Scotland in relation to UK average

Sources: Phillips, David and Tetlow, Gemma (2014),

Deutsche Bank Research



term phenomenon; the difference or gap of about 10% has existed since the

1980s at least.16

A well-developed system of fiscal equalisation as in Germany,

for instance, does not exist in the United Kingdom.17

Expenditures in Scotland

(as in Wales and Northern Ireland) have so far largely been funded via lump-

sum allocations from the (UK) national budget. Estimates show that the Scottish

government was responsible at the latest reading for around 70% of public

expenditure in that region (Wales 56%, Northern Ireland: 53%)18

; however, this

was generally not funded via local taxes, but via the allocations discussed.

The size of the allocations and thus the total expenditure level hinge on the

respective decisions taken in the framework of the (UK) national budget and of

the expenditures determined in England.19

The reason for this is that the annual

changes in the lump-sum allocations to the regions are largely based on a

mechanistic formula – the so-called “Barnett formula”. This formula, which came

into existence at the end of the 1970s, focuses on redirecting to the inhabitants

of Scotland (and also the other UK regions) the identical absolute per capita

changes (in GBP) of comparable services when there is a change in the

provision of services in England. It makes absolutely no attempt to determine

local needs, but instead considers to what extent tasks are decentralised, i.e.

delegated to the corresponding regional government.20

Since part of the task is

already funded by regional taxes, this is also taken into account when funds are

allocated.

The allocation formula has been heavily criticised for some time, both because

of Scotland's still relatively favourable position as well as the formula's

problematic reciprocal and/or incentive effects with taxes collected on a

decentralised basis. This reciprocal effect also influences the debate about

greater tax autonomy, because without a simultaneous change of the “Barnett

formula” an increase in tax autonomy can lead to greater regional disparity on

increases or cutbacks in lump-sum transfers and therefore on public

expenditures in relation to the different parts of the country.

Revenue autonomy being expanded

The decentralisation of expenditures and administration achieved since 1999 is

not (yet) mirrored on the revenue side. This is problematic from an economic

standpoint since it involves a violation of the principle of fiscal equivalence – i.e.

the linking of autonomous decisions via both expenditures and their funding –

and thus encourages the trend of steadily increasing expenditures. Until

recently, all taxes – except for those at the local authorities level – were

collected by the national tax authority. Moreover, the Scottish government –

alone among the regional governments – has had the right to raise the standard

rate of income tax by up to 3 pp. However, it has never made use of this right.21

Given that so far most taxes have been collected and administered at the

national level it is difficult to determine exact figures on the revenue volume

raised in the individual regions. This also applies to the tax revenues generated

on gas and oil production in particular. Relevant figures have become available

only recently from both the Scottish government and the national tax authority.

16

See Phillips, David and Tetlow, Gemma (2014), p. 6. 17

To a certain degree – this varies according to the region – the volume of local tax revenues (such

as the council tax) is collected and then distributed or redistributed between the local bodies of

government. See also IFS Green budget (2011), p. 13ff. 18

See Trench, Alan (2014), p. 321, in Lütgenau, Stefan (2014). Fiscal Federalism and Fiscal

Decentralization in Europe, pp. 321-341. 19

The following discussion applies in principle also to Wales and Northern Ireland. 20

For a more detailed discussion of the following two sections see Phillips, David (2014), p. 17ff,

Trench, Alan (2014), p. 322 and box 22. 21

See Gwilym, Eurfyl ap (2014), p. 65f and Stuart, A. et al., p. 332ff. Taxing an independent

Scotland, in: Oxford Review of Economic Policy, Volume 30, No. 2, pp. 325-345.

The "Barnett formula"* 22

Even before the formula was introduced at the

end of the 1970s Scotland in particular

reported higher allocations per capita, so the

expenditure level per capita was also higher

than in England. The formula was designed at

the time in such a way that on equal population

growth in Scotland and England this initial

difference would have been neutralised over

the course of time. Owing to the longlasting

relatively smaller growth of the Scottish

population, however, this effect has so far

failed to materialise.

The differing degree of decentralisation is

taken into account by various factors. To this

end, a value between 0% (not decentralised)

and 100% (fully decentralised) is set for all

ministerial sub-programmes. This is to take

into account that certain expenditures are only

incurred in England, for example. This is the

case if these expenditures are decentralised

and not funded from the national budget in all

regions. For instance, the national transport

ministry is the competent authority only in

England and Wales when investment in the

railway network is increased. Wales is thus

given the value of 0% in this category and

therefore does not obtain extra funding if there

are plans to increase this item in the (UK)

national budget. Scotland and Northern Ireland

receive the factor 100% and are therefore

accorded higher funding for investment to the

same extent as England and Wales. Therefore,

there are numerous different factors in a

national comparison.

*See Phillips, David (2014) for a detailed discussion.

Business as usual? The Barnett formula, business

rates and further tax devolution. IFS Briefing Note BN

155, chapter 2 in particular.



However, these generally differ from one another. This problem is all the more

acute when the issue is distributing the tax revenues generated on North Sea oil

and gas production.

Disregarding these “offshore” revenues, per capita tax receipts in Scotland, at

98.3%, are slightly below the national average.22

By contrast, including the

“offshore” revenues (defined according to Scotland's geographic share of the

North Sea), the latest reading puts the share at 108.5% (2008/2009: still

122.6%). The offshore revenues are very volatile, with their share most recently

having nearly halved within a year (fiscal 2011/12 to 2012/2013); the same

applies to the share in total Scottish taxes (from 21% to 12%). From a fiscal

standpoint Scotland's public finances thus depend heavily on oil and gas

production. Proponents of independence should keep that in mind, particularly

in light of the recent drop of the oil price. In fiscal 2012/13 the offshore receipts –

unlike in most of the preceding years – were unable to plug the gap between

expenditures and revenues excluding offshore.

Autonomy in the area of tax policy is to be significantly expanded in the coming

years (2015 and 2016)23

. In 2012 (as part of the Scotland Act 2012), the region

saw the establishment of a local tax authority (Revenue Scotland) and Scotland

was given the right to impose taxes on land and property transfers24

as well as

to introduce new taxes (with the authorisation of the UK Parliament in London).

As of 2016 the Scottish government will also be able to have a say on the use of

a share of the national income tax (SRIT). The related law defines who is a

Scottish income taxpayer: put simply, this depends on the taxpayer's place of

residence. Income tax will continue to be administered by the national tax

authority. However, the Scottish government may make autonomous decisions

on a Scottish income tax rate. This will be like a surcharge on the national

income tax. In turn, the national tax rate will be cut across the board by 10 pp.

So if the Scottish government sets a rate of this magnitude, the full tax burden

on the Scottish taxpayer will not change at all. If the rate is higher, the tax

burden for Scottish taxpayers will increase in relation to the national rate. If it is

lower than 10%, the Scottish taxpayer will have a smaller burden. So if, for

example, the Scottish rate of income tax (SRIT) is 9%, the tax load on Scottish

income taxpayers will be 19%, 39% or 44% (the current rates in the UK are

20/40/45%, depending on the level of taxable income). The Smith Commission

set up at the time of the Scottish referendum recently proposed, inter alia, even

further-reaching plans for more tax autonomy. The statutory requirements for

this have been mapped out just recently (see box 23).

If the additionally planned changes are adopted, the concessions made to

Scotland should – at least from a financial perspective – actually suffice to

address key demands being made by independence advocates.

22

For more on the numbers see David and Tetlow (2014). Particularly the per capita volume of

income tax falls short of the UK average in Scotland. 23

Ibid. From 2015 Scotland is also be allowed to issue its own bonds worth up to a maximum of

GBP 2.2 bn and thus borrow at its own discretion. 24

These will replace the UK Stamp Duty Land Tax (SDLT) and the UK Landfill Tax.

Plans for further tax autonomy 23

On the basis of the recently published Smith

Commission Report (Nov. 27, 2014), compiled

by a commission comprising representatives of

all of Scotland's political parties, further

taxation powers, inter alia, are to be devolved

to Scotland in response to the September

referendum.

Firstly, the report proposes to enable the

Scottish parliament to largely set income tax

rates and brackets itself (while all other

aspects of income tax remain in the hands of

the national parliament, including income tax

on savings interest and dividends, personal tax

allowance, deductions etc.). The lump-sum

allocations are to be reduced accordingly.

Secondly, in future the first 10 pp of VAT will

flow to the Scottish budget. Here, too,

allocations are to be cut back accordingly.

All the other taxes and duties, including social

security contributions, corporation tax, taxes on

oil and gas production and consumption taxes

in particular, remain unaffected by these

changes and will continue to be dealt with in

the national parliament.

With presentation of the working paper

Scotland in the UK: An enduring settlement

(Jan. 22, 2015), the legislation process for a

new Scotland Bill has been launched.

For a detailed discussion see: The Smith Commission

(2014). Report of the Smith Commission for further

devolution of powers to the Scottish Parliament.

27 November 2014.



Belgium: Increasing division

Belgium is a deeply divided country, both politically and socially. Following the

parliamentary elections in 2010 it took 541 days to form a government. The

underlying political conflict has been smouldering for much longer, though. In

the Flemish parts of the country a substantial swath of the population calls for

independence for Flanders. In Belgium's 2010 parliamentary elections some

44% of the votes in Flanders were cast for the independence parties N-VA

(31.7%) and Vlaams Belang (12.3%). By contrast, in the French-speaking parts

of the country a majority of the parties, such as the Socialists, who are the

strongest political force, call for a strong central state and no further division of

the country.

The country's empty public coffers – public debt came to 104.5% of GDP in

Belgium in 2013 – further exacerbated the conflict in the course of the financial

crisis. In the economically thriving northern part of the country (58% of economic

output) the view is widely held that ultimately the north always has to foot the bill

for the south. Besides Flanders in the northern half and Wallonia in the southern

half, Belgium also comprises the Brussels-Capital Region, which has a special

role. Even though the Brussels-Capital Region is completely surrounded by

Flanders, its population is largely francophone.25

The country is split noticeably along economic lines: per capita income in

Flanders (at EUR 33,600) is more than one-third higher than in Wallonia (EUR

24,600). Brussels (EUR 62,000), as a city region in its own right and seat of the

European institutions, has a special position in this context. The unemployment

rate in Flanders is also much lower than in Wallonia (5.0% to 11.3%), as is the

poverty rate (9.8% to 19.2%). There are even marked differences in life

expectancy (81.4 years to 78.9).

Today's diverging economic conditions between north and south only developed

in the course of the past 60 years. In 1955, Wallonia was still the more affluent

part of Belgium. Rich in iron and coal, this area prospered economically

following World War II. The 1960s saw the start of the downturn there, with

Flanders subsequently assuming the leading economic role from the 1970s. In a

comparison with other European countries (EU-15) it is striking that the gap that

was opened up between the two regions is mostly due to the poor performance

in Wallonia and not so much to the economic success in Flanders. Since 2000

the gap between the two regions has not grown any larger.

On a societal level, the situation in Belgium has eased of late. Following the

formation of a government in 2011 the constituent parties concluded

negotiations agreeing the so-called “sixth State Reform”26

. Its main focus is on

the continuation of decentralisation efforts that got underway with an initial

reform in 1970. The new arrangement came as a direct result of the political

conflicts and accommodated the Flemish desire for greater self-determination.

Thanks to the far-reaching concessions of the central government the

independence debate temporarily lost some of its momentum. In the

parliamentary elections of 2014 the share of the vote for the N-VA and Vlaams

Belang in the Flemish regions also decreased by around 6 pp, to 38.3%.

25

In 57% of the households in Brussels French is the only language used for everyday interaction,

while 9% speak French and Dutch and 11% speak French and a different language. By contrast,

Dutch is the sole language spoken in only 7% of Brussels households, and neither of the two

languages is used in the other 16%. 26

"State Reform" has taken place in different stages, beginning in 1970. The initial reform was

followed by programmes in 1980, 1988/89, 1993, 2001 and 2014.

Brussels 19%

Flanders 58%

Wallonia 23%

% , 2011

Belgian GDP: Regional shares 24

Source: Eurostat

0 20,000 40,000 60,000

Brussels

Antwerp

Vlaams-Brabant

Brabant Wallon

West-Vlaanderen

Oost-Vlaanderen

Limburg

Liège

Namur

Luxembourg

Hainaut

GDP per capita

GDP per capita in the provinces of Belgium 25

Red: Flemish provinces

Soruce: Eurostat

50

60

70

80

90

100

110

1955 1985 2005

Wallonia Flanders

Wallonia and Flanders switch roles 26

GDP per capita, % of EU-15 average

Source: Leibfritz (2009)



Decentralisation continuing apace

Efforts to decentralise state structures have been underway for a long time. The

biggest changes came with the State Reform at the end of the 1980s. At that

time, the ratio of public expenditure at the regional level increased from 13.0%

to 28.1%. Since then, the percentage has climbed almost continuously, driven

partly by further reforms in 1993 and 2001, and reached 36.4% in 2012. The

ratio is expected to increase further in future. The recently adopted “sixth State

Reform” additionally reinforces the tax-collecting competences of the regions

and guarantees the municipalities27

higher transfers from the central

government, expanding the responsibilities of the regions at the same time. The

amended version of the “Loi spéciale de financement” only took effect in

summer 2014 and therefore its impact will not materialise until sometime in

future. All in all, it will transfer further budget funds equalling 4.7% of Belgian

GDP from the central government to the regions.

The bulk of tax revenue to date has been generated at the central level,

although a substantial portion has automatically flowed to the regions. In 2013

these funds added up to 64.6% of regional receipts, mainly from shares in

income tax and value added tax. The latest reform changes the existing

mechanism with regard to income tax: from 2015 the regional governments will

receive about 25% of the income tax volume collected. This will be implemented

by a type of surcharge, i.e. the regions will have a limited right to set tax rates,

tariff/tax classes and deductions themselves. As a result, the share of receipts

from local taxes in the regions will rise to 73.3%. Value added tax will continue

to be collected entirely by the central government and about 50% of receipts will

be handed on to the regions according to a given formula.28

As regards lower-

volume taxes, the regions often already have a far-reaching level of autonomy.

Regional transfers: Flanders pays, but how much?

An equalisation mechanism has been in place between the regions since 1988.

The equalisation payments are transacted by the central government. At

present, transfers flow to both Wallonia (approx. 0.2% of GDP) and Brussels

(approx. 0.1% of GDP), but not Flanders. In fact, ever since the system was

introduced no funds have been transferred to Flanders, whereas Wallonia has

been receiving annual transfers since 1988 and Brussels since 1997. This

system, too, was tweaked in the framework of the latest State Reform, which will

lead de facto to a slight decrease in the transfers to Wallonia in the medium

term. The decisive factor for the calculation is income tax per capita and the

extent to which it deviates from the national average. If a region falls short of this

average, it receives transfers.

The volume of the total interregional transfers cannot be measured directly.

Since, unlike in Germany, for instance, payments between the regions are not

reported, their volume can only be estimated using workaround methods. The

estimates are often already slightly outdated, since important indicators on tax

and social security transfers are only published with a time lag. A study

conducted by the KU Leuven (Buyst et al., 2012) puts the transfers from

Flanders in 2009 at 1.78% of national GDP, of which 0.08% went to Brussels

and 1.7% to Wallonia. In methodological terms, the difference is taken between

the income generated in the regions as a result of taxes and social security

deductions and the allocations that return via transfers from the central

27

Apart from the regional governments there are also linguistic communities which shoulder certain

tasks of state – such as education in particular – and receive funds from the central government

for doing so. To simplify matters, we shall not differentiate explicitly in the following between the

two and shall group them under the term "regions". 28

Besides the tax revenues generated in a region, a role is also played by population distribution.

0%

5%

10%

15%

20%

25%

30%

35%

40%

85 87 89 91 93 95 97 99 01 03 05 07 09 11

%, 1985-2012

Belgium: Public expenditure at regional level 27

Shaded area: State Reform

Source: OECD

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Flanders Wallonia Brussels

Before After

Revenues from regionally imposed taxes before/after State Reform 2014 28

% of total revenues

Source: NBB

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

2007 2008 2009

Flanders Brussels Wallonia

Net interregional transfers 29

% of Belgian GDP

Source: Buyst et al. (2012)



government and the social insurance plans. The authors refer to the years 2008

and 2009 as exceptions since at the time funds were retained at the central

level to finance efforts to manage the crisis. In future, the transfers are to run

again in the dimensions seen in 2007 when Flanders transferred 4.79% of GDP

to Brussels (0.23%) and Wallonia (4.55%).

According to a different study conducted by the National Bank of Belgium (Dury

et al., 2008), however, Flanders' payments in 2005 were only equivalent to 1.9%

of national GDP. Hence, the exact volume of interregional transfers is difficult to

pinpoint. The fact that Wallonia benefits from the Belgian system more than

Flanders at least in financial terms is obvious, though, considering the economic

differences.

Even though the latest State Reform pledges greater autonomy to the regions,

at least the direction of the transfer flows is surely not about to change in the

foreseeable future. Whether the temporary easing of the conflict as a

consequence of the ongoing decentralisation of government will continue in

future remains to be seen. It is also doubtful whether Flanders will be able to

maintain the scale of its large economic lead over Wallonia in the first place.

Forecasters expect the population to age more quickly in the Flemish region,

meaning that in future lower tax receipts there may possibly be set against

higher pensions and social security claims, so the payment streams could

decrease in this way.

Italy: Large gulf between north and south

Like in Spain, there are asymmetries also in Italy in terms of the constitutional

position of its regions. Italy is composed of 20 regions in total, five of which

(Valle d'Aosta, Friuli-Venezia Giulia, Sardinia, Sicily and Trentino Alto Adige

[=South Tyrol]) have special autonomy status. This means that, unlike in Spain,

there are regions at both the upper end and the lower end of regional income

distribution that enjoy this special status. The regions in question have

additional powers and greater financial autonomy in respect of healthcare and

education as well as public infrastructure. Trentino Alto Adige is a special case

again in this context, as the regional level of government there has mainly a

coordinating role. With the special status for Trentino Alto Adige the core

competences were essentially handed to the next-lower level, i.e. to the

autonomous provinces of Bolzano-Alto Adige and Trentino. By contrast, Veneto

only has the status of a “normal” region, such as Lombardy or Emilia-Romagna,

which are also among the regions with the highest per capita income.

Since 1995, South Tyrol, Veneto and Lombardy have lost a bit of ground in

income terms on a national comparison. This is to be explained in particular by

catch-up effects among the economically weaker southern regions during this

period. Recently, however, the gaps between South Tyrol and Lombardy vis-à-

vis the rest of the country have widened again (see chart 30).

Regional outlays are mainly funded via pro rata and locally imposed tax

receipts. Among the regions with regular status these accounted for about 77%

of total revenues in 2008, and among those with autonomy status about 82%.

Nearly 50% of this total is attributable to the share in the value added tax.

However, this share is not proportional to the regional receipts and has a

horizontal redistribution component, equating it in principle with a transfer.29

29

See E. Longobardi (2011). From transfers to tax "co-occupation": the Italian reform of

intergovernmental finance. Working paper, p. 9.

110%

115%

120%

125%

130%

135%

1995 1998 2001 2004 2007 2010

South Tyrol Veneto Lombardy

GDP per capita in South Tyrol, Veneto and Lombardy 30

% of national average

Source: Istat

0%

20%

40%

60%

80%

Taxes Transfers (central gov’t

and EU)

Other revenues

Regular status Autonomy status

Revenues in regions with regular status and autonomy status 31

2008, % of total regional revenues

Source: Longobardi (2011)



Generally, the regions have little freedom to impose their own taxes, even

though their tax autonomy was slightly expanded in the wake of the

constitutional reform of 2001. On the apportionment side, they also have little

latitude since they have to expend the lion's share on funding the health system,

which is a regional-level duty.

Given the differences firmly established for decades between the economically

strong northern part of the country and the weak southern part, the issue of

regional redistribution has long been a matter of heated controversy. In some

areas of the northern region parties aiming for autonomy have at times been the

strongest political groups. The Northern League, which called for the secession

of the northern half to form the “Republic of Padania” in the 1990s, is currently in

power in the regional governments of Lombardy and Veneto. There,

dissatisfaction with Rome and the impression that they have to subsidise the

rest of the country are very widespread. In each and every one of the seven

parliamentary elections held in Italy since 1992 this has been manifested in an

average share of over 18% of the vote for the Northern League.30

In Friuli-

Venezia Giulia and in Piedmont the Northern League has likewise averaged

over 10% of the ballot. The League does not have a strong base in South Tyrol

because the electorate there usually cast over half their votes for the region's

own political parties.

Transfers from northern Italy to the “mezzogiorno”

It is undisputed that northern Italy carries the main burden of regional

equalisation. This is the conclusion reached despite methodological differences

in diverse politically independent studies that have sought over the past few

years to calculate the net flows in Italy's financial equalisation scheme. Chart 33

illustrates the regional per capita payments, with a positive value signifying a net

payer position. In all these analyses, Lombardy, Veneto and Emilia-Romagna

rank in first, second or third place. All the regions south of Rome are net

recipients.

Given the absence of comparable datasets, differing base years and the fact

that different methods were used to calculate the net fiscal transfers, the

concrete per capita payments vary appreciably in some cases, although the

ranking is usually very similar. The most recent study and at the same time the

most convincing one in methodology terms was conducted by Ambrosanio et al.

(2010).31

This holds especially since the per capita transfers (in light blue) are

indeed calculated as a zero-sum game between the regions, i.e. produce a per

capita transfer of 0 on average.32

The scale of the resultant redistribution is

huge. It suggests that (on average) taxpayers in Lombardy see about 30% of

their taxes go to the poorer regions via transfers. Conversely, the residents of

Calabria receive 55% more than they pay in taxes themselves.

It is striking that among the first five regions there are none with autonomy

status. The first of these is South Tyrol in sixth place which, according to

calculations by Ambrosanio et al., is a borderline net payer.33

As in the case of

30

In the last two elections, however, the Northern League had a rather poor showing. In the

European elections in 2014 it obtained merely 6.16% (combined with the South Tyrol party called

"Die Freiheitlichen"), and at the last Italian parliamentary election in February 2013 only 4.09%. 31

Ambrosanio, M., Bordignon, M., and Cerniglia, F.M. (2010). Constitutional reforms, fiscal

decentralization and regional fiscal flows in Italy. In N. Bosch, M. Espasa and A. Solé Ollé (eds.).

The Political Economy of Inter-Regional Fiscal Flows, pp. 75-107. Cheltenham, Edward Elgar. 32

Given differing calculation methods the other studies show a positive overall balance, which might

partly result from factoring in EU transfers. 33

The fact that most of the studies rank Trentino Alto Adige and the Valle d'Aosta among the largest

net recipients is due to the complex calculation method and the relatively small population. The

difference can be largely explained by Ambrosanio et al. having used what is known as the

"benefit approach". This means that expenditure categories showing public goods that benefit all

0 5 10 15 20

Lombardy

Veneto

Friuli-Venezia Giulia

Piedmont

Liguria

Trentino Alto Adige

ITALY

Emilia-Romagna

Tuscany

Marches

Umbria

Northern League performance in elections to Italian parliament, 1992-2013 32

%, average for all elections

Sources: Italian Ministry of Interior, Deutsche Bank Research

-4000 -2000 0 2000 4000 6000

Lombardy

Veneto

Emilia-Romagna

Lazio

Piedmont

Trentino Alto Adige

Friuli-V. G.

Tuscany

Marches

Valle d’Aosta

Liguria

Abruzzo

Umbria

Apulia

Campania

Basilicata

Sardinia

Molise

Sicily

Calabria

Ambrosanio et al. 2005

Arachi et al. 1996-2002

Brosio, Revelli 1997

Fondazione Agnelli 1995

EUR per capita; positive balance = net payer; data based on year(s) indicated below

Lombardy and Veneto highest net payer regions in Italy 33

Sources: Ambrosanio et al. (2010), Arachi et al. (2006), Revelli (2003), Fondazione Agnelli (1998)



Spain, special autonomy status appears to generate fiscal advantages also in

the Italian system. The widespread desire for greater autonomy in affluent

regions, such as Lombardy and Veneto, therefore seems understandable.

Germany and France: Autonomy movements have no major political significance

In connection with European autonomy movements it is of no small interest to

see where such movements fail to attract a major following, as in France and

Germany for instance. This is noteworthy because the two largest EU member

countries may be seen as opposite poles in terms of decentralisation and

federalism – with France and its centuries-long tradition of strong centralisation

set against historically fragmented federal Germany. Indeed, France has both

"Basque" and "Catalonian" areas on its border to Spain, although there the

desire to secede from France does not enjoy broad-based support. The more or

less Bilingual Alsace does not have any strong autonomy movement either. One

of the main exceptions is Corsica. There has been a string of separatist attacks

there over the past few decades. In the meantime, though, the largest separatist

organisation has declared its intention to abandon its armed struggle for

independence. The Brittany region has also been home to autonomy efforts – albeit

with varying intensity – for centuries. However, separatist parties and movements

do not play any significant role there at present. In Germany's case, Bavarians are

probably the population group with the greatest awareness of their regional

heritage, yet this has not led to a significant independence movement. No doubt a

major reason for this is that the Länder have extensive competences in key policy

areas and play an important part in national legislation via the Bundesrat, the

second chamber of parliament.

Germany and France are at opposite ends of the spectrum also with regard to

income disparity. Chart 35 illustrates the percentage difference between the 20%

quantile and the 80% quantile of regional per capita GDP.34

It indicates the

amount by which GDP per capita in a region that just barely qualifies for

inclusion in the best 20% outstrips GDP in a region that falls by a whisker into

the lowest 20%. This measure of disparity thus eliminates distortions caused by

outliers such as Paris, Brussels or metropolitan London with their far above

average incomes. Going by this metric, France is the country with the most

egalitarian society. This naturally provides less fertile ground for horizontal

distribution conflicts than in other countries, which probably reduces the

economic motivation for independence.

Excluding metropolitan London, regional income distribution would be relatively

egalitarian in the United Kingdom, too. In Spain and Belgium, the income

disparities are considerably bigger, but by no means do they play in the same

league as Italy. Germany is a special case on account of the country's

reunification, because if the east German states were excluded the regional

income disparities would actually not be excessively pronounced by European

standards.

In Germany there is a large degree of financial integration between the

Federation, the Länder (the individual federal states) and the municipalities. This

is the result of the division of responsibilities prescribed by the Basic Law, the

Italians are not charged to the geographical area where they are incurred, but instead are

allocated to all the regions on a proportional basis. This applies to, say, public administration,

which is primarily linked with the capital city of Rome, but also to national defence, which causes

disproportionately high spending in border regions and given the small population in South Tyrol

and the Valle d'Aosta appears there as a high net transfer in the so-called "cost approach". 34

To obtain a comparable number of regions for analysis, we look at the NUTS 1 level for Germany

and the United Kingdom, and the NUTS 2 level for Spain, France, Italy and Belgium.

Bavaria and the Federal Republic of

Germany 34

Bavaria is Germany's largest Land (federal

state) in terms of area and the second largest

after North Rhine-Westphalia in terms of

population with roughly 12.6 m inhabitants. It

has the highest per capita GDP of all the

territorial states at 114% of the average.

Bavaria generates nearly 18% of German

GDP. In a comparison of the regions discussed

in this report (and disregarding the city regions

of London and Brussels) there are only two

subregions (Antwerp in Flanders [BE] and

South Tyrol [IT]) with a higher GDP per capita.

In absolute figures, Bavaria is a key player also

in a European comparison. By population, it

would rank at No. 10 among all the EU states

and thus ahead of countries such as Belgium,

Czech Republic and Portugal. This applies to

GDP in absolute figures, too: Bavaria would

rank 7th in the EU, after the Netherlands.

Bavaria's comparatively dynamic economic

growth especially since the end of the 1970s

has fed through positively also from a fiscal

standpoint. While Bavaria, among others, had

always been a recipient Land in Germany's

financial equalisation system until 1988, it has

been a donor ever since 1993. Since 1995,

Bavaria has paid about EUR 2.4 bn annually

on average (equalling roughly 0.6% of

Bavarian GDP on average) or around EUR 200

per capita into the actual Länder financial

equalisation programme in the narrow sense.

The Bavaria Party, which advocates an

independence referendum, has not been

represented in the state parliament since the

1970s. However, in Bavaria's first postwar

elections (back in 1949 and 1954), the party

gained no less than 17.9% and 13.2% of the

vote respectively.

30%

15%

22%

41%

48%

61%

70%

0%

10%

20%

30%

40%

50%

60%

70%

FR GB ES BE DE IT

Germany excl. east German Länder

Relationship between 20% and 80% of regional per capita GDP 35

Differences in %, 2011




sharing of tax revenues, their redistribution between the different levels of

government and the co-financing of many tasks. On balance, about 70% of total

tax receipts are split up and redistributed between the different levels of

government in a four-stage process. The basis of allocation, in principle, is the

ratio of actual revenues35

to a notional income. The system harbours substantial

incentive problems owing to the high absorption rates for recipient countries;

these undermine their own efforts to bolster their economic strength and/or

revenue-generating capacity.36

Unlike in Spain though – as long as certain

direct transfers from the Federation to several Länder are stripped out of the

equation – the financial equalisation system does not alter the pecking order of

the Länder by fiscal capacity.

A reform of financial relations in the German federal system and thus also of the

redistribution mechanisms – which is also a statutory obligation that must be

fulfilled by 2020 at the latest owing to the expiry of current arrangements –

requires overcoming the Gordian knot as well. As there are significant

differences in economic strength, every change will produce winners and losers.

Chart 36 shows that especially the east German Länder continue to exhibit a

significantly lower revenue-generating capacity than the west German Länder.

The city-states assume a special role. The extent of losses and gains depends

on the degree of redistribution, which ultimately has to be determined politically.

Despite this extensive redistribution system, though, there are no aspirations to

achieve autonomy or even independence.

The financial illusion of independence

The desire for special rights, far-reaching autonomy or even independence is

supported to a relatively large extent by a belief in the economic strength of the

given region. The financial implications resulting from de facto independence go

beyond the savings achieved by exiting the regional financial equalisation

scheme of the respective country. Despite the fact that advocates of

independence like to gloss over the potential risks, even in the event of

immediate membership of the single European market and the eurozone there

would be a number of potential financial disadvantages:

— Higher costs of borrowing: The disadvantage of small countries may be

illustrated by comparing Germany and Austria. Even though Austria has a

higher per capita GDP, lower sovereign debt and a nearly identical

unemployment rate, the risk premium on Austrian bonds is higher. Due to

the much lower issuance volume Austrian bonds are perceived to be less

liquid, so investors demand a liquidity premium. If Scotland had attained

independence it would also obtain a good rating, but nonetheless it would

have to pay a premium on British bonds.37

For Catalonia, which according to

the several rating agencies currently does not even rate as “investment

grade”, it would be a much more expensive undertaking. While the Basque

Country and also Navarra currently has a better rating than Spain with some

agencies, in fact, in the event of independence the implicit central

government guarantee would disappear, possibly also weighing negatively

on the rating. Conversely, though, a loss of economically strong regions

would also jeopardise the Spanish rating and entail higher funding costs.

35

The definition of actual revenues in this context, i.e. of fiscal capacity, is itself subject to huge

discretionary latitude, however, so a purely objective determination of the degree of redistribution

is extremely difficult. 36

See also: Bundesbank (2014). The reform of financial relations in the German federal system in:

Monthly Report. September 2014, pp. 33-52. 37

If Scotland were independent it could reckon with an A rating, i.e. down several notches on the

UK's Aa1 rating. See Moody’s (2014). Rating Scenarios for an Independent Scottish Sovereign.

50 75 100 125 150

Hamburg

Bavaria

Hesse

Baden-Wuerttemberg

North Rhine-Westphalia

Rhineland-Palatinate

Lower Saxony

Schleswig-Holstein

Bremen

Berlin

Saarland

Brandenburg

Saxony-Anhalt

Saxony

Thuringia

Mecklenburg-Western Pomerania

Before financial equalisation*

After financial equalisation**

* VAT shares fully distributed by population

** After preliminary (horizontal) VAT equalisation, Länder financial equalisation and general supplementary federal grants

Strongly diverging fiscal capacity in Germany 36

% of per capita average, values for unweighted population, incl. municipal taxes

Sources: Bundesbank, Deutsche Bank Research



— Financial burden from assumption/distribution of legacy debt. Both Spanish

regions would have to assume a considerable share of Spain's sovereign

debt. Scotland would also have to shoulder a share of national debt.

Whether this would be calculated on the basis of relative GDP figures,

population or past financing balances, would ultimately be decided by a

political negotiation process. Depending on the division, though, this would

result in substantial fiscal burdens for the then independent regions.

— Disruptive trade effects: The rest of Spain is by far the largest trading partner

for the Basque Country and Catalonia; the same applies to the United

Kingdom in the case of Scotland as well as to Italy with Veneto. This shows

that despite the single European market national borders often continue to

play a significant role. Even though trade between Spain and Catalonia

would of course not stop altogether, it seems exceedingly unlikely that the

intensive trade relations would survive a (possibly discordant) separation

without sustaining any damage whatsoever. The fact that about three times

as many Catalonian goods are “exported” to other regions of Spain as to the

geographically comparable and much larger France impressively shows that

borders (whether political, linguistic, cultural …) still play an important part in

a united Europe.

It has to be affordable!

At this point it is not our objective to do the sums for every region on how much

it could gain, or perhaps lose, in the event of separation. However, it is important

to understand that such an emotionally charged issue may occasionally cloud

the view of the economic realities. Setting up an independent administration,

international representative offices, a military defence organisation etc. naturally

comes at a price. Objectively speaking, there are not many channels via which

independence can actually generate financial advantages. One of the few, and

perhaps the most obvious, is the disappearance of financial transfers to other

parts of the country. Thus, only in a prosperous region (relative to the rest of the

country) is it possible to maintain the fiction that going it alone would be the

better option. In other words: one has to be able to afford it.

Frank Zipfel (+49 69 910-31890, [email protected])

Stefan Vetter (+49 69 910-21261, [email protected])

Daniel Pietzker

© Copyright 2015. Deutsche Bank AG, Deutsche Bank Research, 60262 Frankfurt am Main, Germany. All rights reserved. When quoting please cite

“Deutsche Bank Research”.

The above information does not constitute the provision of investment, legal or tax advice. Any views expressed reflect the current views of the author,

which do not necessarily correspond to the opinions of Deutsche Bank AG or its affiliates. Opinions expressed may change without notice. Opinions

expressed may differ from views set out in other documents, including research, published by Deutsche Bank. The above information is provided for

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